Japan’s latest attempts to exit the crisis using expansive policies, coupled with the problem of its ageing population, should be watched closely by the rest of the world.

Ever since the stock market and housing bubbles burst, dealing a double blow to the Japanese economy almost two decades ago, there has been very little good news from Japan. The country has spent this time immersed in what many call “the lost decade” (although many are now starting to talk about the “two lost decades”) going in and out of recessions, without ever managing to convince the world that it is finally over the problems that began to plague it at the beginning of the nineties. And it was in the midst of this scenario that Japan became the first country to use the zero-interest rate policy (ZIRP), which it is still unable to leave behind. As is usually the case with major recessions, the country combines this monetary policy with a very expansive fiscal policy, which led what had been one of the most prudent countries in the OECD in fiscal terms up until the nineteen eighties, to become the country with the highest ratio of public debt to GDP in the world, including Greece, Lebanon, or Zimbabwe.

This crisis came about after what some called the “Japanese miracle” of reconstruction and growth after the Second World War, and which some countries observed with a certain amount of fear. There was widespread feeling that the US was being invaded by Japanese interests in the eighties, but a growing respect for China began to emerge. And what might appear to be just another crisis that would lead to a relatively short recession followed by a strong recovery, turned over the years into a structural crisis from which it seems extremely difficult to escape.

One aspect of Japan’s crisis which is unique and has generated a great deal of interest is the curiously persistent deflation. One could be forgiven for thinking that falling prices in the form of deflation, in contrast to inflation, would actually be very welcome. Nevertheless that is not the case as it can cause a large number of problems, one of which is that when people think that goods and services will be cheaper in the future, they put off buying tem and demand falls, and in turn production. Moreover, if the prices of goods go down and salaries do not fall at the same rate, then companies see their profit margins eroded. After all, it is not easy to put salaries down.

This combination of very low or negative growth and deflation, and frustration at the duration of the crisis, led Shinzo Abe’s government to propose last January a blend of expansionary fiscal and monetary policies aimed at generating growth and inflation in a country where the ratio of debt to GDP stands at over 200%. Hence the International Monetary Fund asked for a credible medium-term fiscal consolidation plan.

But the Nippon Government’s proposal also raised other types of questions. First, Germany’s Minster of Finance, then Angela Merkel, showed their concern about the new plan, for two different reasons that were nevertheless related. These were the apparent interference in the policy of the Central Bank, which flies in the face of the German belief that a Central Bank should be totally independent, and the fear that said policies would weaken the Yen to increase Japanese exports, which would put pressure on the competitiveness of products sold in Euros.

Over the last two decades, many economists have cited Japan’s economic situation as an example of the failure of Keynesian policies, given that Japan applied the typical combination of expansive fiscal and monetary policies which did not lead to a significant recovery, and pushed the country into a dead end situation of close to zero interest rates and rocketing public debt. Others laid the blame at the door of structural factors rather than economic policies. Whatever the case, it is curious that the same combination of expansive policies is making a comeback and is considered a fairly heterodox approach today, having often been seen as orthodox in the past.

There is a specific structural aspect that is often mentioned as a special factor that is affecting the results of policies in the case of Japan, and that is the country’s ageing population coupled with a drop in the overall population. This combination, along with other effects, is threatening the sustainability of the current Japanese pensions system. And for younger generations this means that it is better to save more in order to ensure a long retirement during which the state will not be able to contribute as much as it has done to date, which means that young people are spending less, pushing demand down further.

Although Japanese newborns can still expect to live longer than those born anywhere else in the world, the tsunami of March 2011 has meant that the elderly in Japan are currently not the longest living older generation in the world, with a life expectancy of 85.9 years for women, and 79.44 years for men. Women in Hong Kong overtook Japanese women in terms of life expectancy in 2011, and Japanese men also fell into second place behind Swiss men.

In the short term the eyes of the entire world are on Japan to see the results of the recently announced package of economic policies. Europe in particular will be watching how Japan handles the problem of its ageing population and its consequences.